Demand analysis 2 Flashcards
Elasticity meaning
The term elasticity indicates responsiveness of one variable to a change in the other variable
Define elasticity of demand
Elasticity of demand refers to the degree of responsiveness of quantity demanded to a change in its price or any other factor
Def of elasticity of demand by marshall
According to Prof. Marshall, “Elasticity of demand is great or small according to the amount demanded which rises much or little for a given fall in price and quantity demanded falls much or little for a given rise in price.
Types of elasticity of demand
- Price
- Income
- Cross
Income elasticity
It refers to the degree of responsiveness of a change in quantity demanded to a change in income only, other factors including price remain unchanged.
Ey= %CQ/ %CY
Cross elasticity
It refers to a change in quantity deamnded of one commodity due to change in the price of another commodity(subsitute or complimentary)
Ec=%CQA/%CPB
Price elasticity
According to marshall, price elasticity of demand is a ratio of proportionate change in the quantity demanded of a commodity due to a given proportionate change in price
Types of price elasticity
- Perfectly elasti demand
- Perfectly inelastic demand
- Unitary elastic demand
- Relatively elastic demand
- Relatively inelastic demand
Methods of measuring price elasticity
- Ratio or percentage method
- Total expenditure method
- Point or geometric method
Ratio/Percentage method
According to this method, elasticity is measured by dividing the percentage change in demand by the percentage change in price.
It is also known as arithmetic method
Ed=%CQ/%CP
Total expenditure method
Total amount of expenditure before and after price change is compared.
Here total expenditure refers to the product of price and quantity demanded.
A) Relatively elastic demand (Ed >1) :
When with a given change in the price of a commodity total outlay increases, elasticity of demand is greater than one.
B) Unitary elastic demand (Ed = 1) :
When price falls or rises, total outlay does not change or remains constant, elasticity of demand is equal to one.
C) Relatively inelastic demand (Ed <1) :
When with a given change in price of a commodity total outlay decreases, elasticity of demand is less than one.
Point or geometric method
Ratio or total expenditure method cannot measure the elasticity of demand at a particular point on the demand curve and therefore this method was developed by prof. marshall
Ed=Lower segment below a given point/upper segment above a given point
Factors influencing elasticity of demand
- Availability of commodities
- Complimentary goods
- Income of consumer
- Durability
- Habits
- Urgency of needs
- Number of uses
- Nature of commodity
- Time period
Availabilty of subsitutes
Demand for a commodity will be more elastic, if its close
substitutes are available in the market. For example, lemon juice, sugarcane juice etc.
But commodities having no close substitutes
like salt the demand will be inelastic.
Complimentary goods
The demand for a commodity which is used in conjunction with other commodities to satisfy a single want is relatively inelastic. For example, a fall in the price of mobile handsets may lead to rise in the demand for sim cards
Income of consumer
Demand for goods is usually inelastic, if the consumer has high income. The demand pattern of a very rich and an extremely poor person is rarely affected by significant changes in the price
Durability
The demand for durable goods is relatively elastic. For example,
furniture, washing machine etc. Demand for perishable goods is inelastic. For example, milk, vegetables etc.
Habits
Habits make demand for certain goods relatively inelastic. For example, addicted goods, drugs etc
Urgency of needs
Goods which are urgently needed will have relatively
inelastic demand. For example, medicines.
Luxury goods which are less urgent have relatively elastic demand.
Nature of commodity
By nature we can classify commodities as necessaries, comforts and luxury goods. Demand for necessaries like foodgrains, medicines, textbooks etc. is relatively inelastic and for comforts and luxury goods like cars, perfumes, furniture etc. demand is relatively elastic
Number of uses
Single use goods have a less elastic demand. Multi-use goods have more elastic demand, For example, coal, electricity etc
Time period
Elasticity of demand is always related to period of time. It varies
with the length of time period. Generally speaking, longer the duration of period greater will be the elasticity of demand and vice-versa. This is because a consumer can change the consumption habits in the long run in favour of cheaper substitutes of the commodities
Importance to producer
Every producer has to decide the price of his product at which
he has to sell it. For this purpose, elasticity of demand becomes important. If the demand for a product is relatively inelastic, he will fix up a higher price and vice-versa. The concept of elasticity of demand is also useful to a monopolist to practice price discrimination
Importance to government
Taxation policy of the Government is based on the concept of elasticity of demand. Those commodities whose demand is relatively inelastic will be taxed more because it will not affect their demand much and vice-versa.
